Alcatel-Lucent Investors Should Embrace The Nokia Merger

| About: Nokia Corporation (NOK)

Summary

ALU investors expected an acquisition, but wanted cash, not all-stock at such a low price.

ALU investors are focusing on the now, not really looking ahead to the future.

In looking ahead, the structure is favorable to long-term investors, and here's why.

After a solid year of speculation, it doesn't seem that anyone is happy with Nokia's (NYSE:NOK) buyout offer for Alcatel-Lucent (ALU). Despite Alcatel-Lucent's stock trading higher by 24% the last three months, mainly the result of M&A speculation, investors remain disgruntled by the near 20% loss it saw after Nokia's offer became public. The reason for this loss is because it is all-stock being offered to Alcatel-Lucent, meaning Alcatel-Lucent's future stock performance is now directly tied to how Nokia performs operationally. If bad, Alcatel-Lucent's stock will not thrive regardless of how the company performs. While this may not seem ideal, there are numerous reasons why the merger could be very lucrative for shareholders with a long-term time horizon.

Admittedly, unless you like what both Nokia and Alcatel-Lucent are doing from an operational standpoint then you're going to have a tough time finding anything positive from this deal structure right now. At Nokia's closing stock price on Wednesday, Alcatel-Lucent would be priced at about $4.25. That's if the deal were to close today.

The problem with an all-stock deal is that it is completely dependent on how the acquiring company's stock performs. Clearly, Nokia's stock will be affected to some degree by how Alcatel-Lucent performs, but not nearly the same as Alcatel-Lucent's performance in relation to Nokia's operations. It is for this reason that I decided to sell my Alcatel-Lucent shares after being a long-time investor. However, my decision to sell is not a reflection of what I expect from the combined company or how I feel about the deal itself, as I simply swapped for a position in Nokia.

First off, Alcatel-Lucent is an enormous asset for Nokia to digest. Had the company offered $5 a share for Alcatel-Lucent, it would've had to raise more debt, unload all of its cash, and still have to use stock. In the end, paying a higher premium means more dilution, and for investors who plan to own the combined company, more dilution is not a favorable solution. Therefore, I like that Alcatel-Lucent will only dilute Nokia's stock by 35%, but will double its revenue. That's a ratio I like as an investor.

That said, I clearly like Alcatel-Lucent, and have explained as much on multiple occasions. Personally, I think Alcatel-Lucent's core networking business is worth more than Nokia's entire offer. This is a high margin business where Alcatel-Lucent has been stealing significant share of Cisco's dominant market presence. This is a bonus area for Nokia, mostly consisting of IP routing, which is a space where Nokia is not a relevant market contender.

Instead, Nokia's interest in Alcatel-Lucent likely stems from synergies in the construction of networks and the potential for 5G network buildouts, not the routing of data and internet. Nokia, Alcatel-Lucent, Ericsson, and Cisco all compete in the construction of advanced mobile networks, like base stations, towers, small cells, etc. This creates a very competitive environment where equipment vendors bid to work with telecom companies.

By combining two of the world's largest global equipment vendors, that competition declines a bit, synergies are created, and the two companies can build on each other's strengths. Specifically, the two companies are thriving in different areas of the globe. Alcatel-Lucent and Nokia both have a large presence in North America and Europe, but last year marked a remarkable year for Nokia in India and Alcatel-Lucent in China. Nokia had new deals in 2G and 3G network construction, 4G deployment, WiFi solutions, security solutions and device management, allowing it to complete a total of 34 deals in India last year. Meanwhile, Alcatel-Lucent struck new and expanded deals with China's three largest carriers to route and help build their 4G and broadband networks.

The point is that while synergies exist between Nokia and Alcatel-Lucent, there are also a lot of areas where each company has its own strengths. Combined, the two companies will be about half the size of Cisco, and larger than Ericsson. That'll give the combined company a great edge in negotiations and with contract biddings.

Furthermore, with more than a billion dollars of cost synergies expected by 2019, and well over $8 billion in net cash between the two firms, investors should feel confident that margins will rise and investments will be robust. Both companies have already expressed their interest to tackle the mobile infrastructure market aggressively by spending about the same amount on R&D as Cisco. With Nokia using all-stock to acquire Alcatel-Lucent, and planning to sell its HERE mapping/navigation business for over $2.3 billion, we might even see another acquisition by the time this deal closes.

All things considered, I really like the prospects of Nokia plus Alcatel-Lucent the way this deal is structured. It may not give me the most immediate gratification but long-term the implications look promising. Specifically, for Nokia to double its annual revenue with only 35% dilution, and expectations for over $1 billion in cost synergies within three years of acquisition, investors can see that this has upside value written all over it.

Together, these two companies will have an unmatched portfolio of radio/fixed access and radio/IP networks. According to Alcatel-Lucent's current CEO, that's what's needed to be a winner in 5G, or the future growth driver for equipment vendors. In other words, there are a lot of reasons to be bullish for the future of this acquisition; you just have to look past the disappointment of yesterday's initial stock reaction. That's why I bought shares of Nokia, and plan to hold long-term for a very lucrative ride higher.

Disclosure: The author is long NOK.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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